class: center, middle, inverse, title-slide .title[ # Principles of Microeconomics ] .author[ ### ECO 2306 ] .date[ ###
Fall 2022
] --- <!-- This sets the color to light sea green for the hover on tables --> <!-- <style> --> <!-- .table-hover > tbody > tr:hover { --> <!-- background-color: rgb(24, 188, 156, .3) !important; --> <!-- } --> <!-- </style> --> class: center, middle, inverse # Chapter 10: ## Consumer Choice and Behavioral Economics --- ## Consumer Theory .pull-left[ - We have looked at **what** people do, but not **why** they do what they do. - Focus on demand side (consumers) - Model decision making - Preferences - Constraints - Optimal choice ] .pull-right[ <img src="data:image/png;base64,#images/why_would_you.gif" width="100%" style="display: block; margin: auto;" /> ] --- ## Preferences and Happiness .panelset[ .panel[.panel-name[Assumptions] How do we model peoples' preferences? .pull-left[ Need to make three assumptions: 1. Completeness 2. Transitivity 3. Non-satiation These assumptions allow us to map preferences--a.k.a. **indifference curves** - Suppose you are faced with three choices: - A: 2 pizza slices, 1 cookie - B: 1 pizza slice, 2 cookies - C: 2 pizza slices, 2 cookies - Assume indifference between A and B - Which do you prefer? ] .pull-right[ <img src="data:image/png;base64,#images/more_cowbell.gif" width="90%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Indifference Curves] .pull-left[ Assumptions 1. Completeness 2. Transitivity 3. Non-satiation Properties 1. Prefer higher indifference curves <font color = 'lightgrey'> 2. Indifference curves are downward sloping 3. Indifference curves *never* cross 4. Only one indifference curve through every bundle </font> ] .pull-right[ <img src="data:image/png;base64,#images/mit_2_1.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[IC 2] .pull-left[ Assumptions 1. Completeness 2. Transitivity 3. Non-satiation Properties 1. Prefer higher indifference curves 2. Indifference curves are downward sloping <font color = 'lightgrey'> 3. Indifference curves *never* cross 4. Only one indifference curve through every bundle </font> ] .pull-right[ <img src="data:image/png;base64,#images/mit_2_2.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[IC 3-4] .pull-left[ Assumptions 1. Completeness 2. Transitivity 3. Non-satiation Properties 1. Prefer higher indifference curves 2. Indifference curves are downward sloping 3. Indifference curves *never* cross 4. Only one indifference curve through every bundle ] .pull-right[ <img src="data:image/png;base64,#images/mit_2_3.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Utility] Utility - rank order bundles of goods/services on a scale (utility) - **utility**: enjoyment or satisfaction people receive from consuming goods/services - **Utils** - don't really exist - ordinal, NOT cardinal - e.g. football rankings vs. measurements/prices What’s the purpose of utility? - It allows you to rank choices - It allows you to weight the different elements of your consumption bundle so you can rank them **Utility function**: a stable, well-behaved mathematical representation of your preferences - How do we represent your feelings about the tradeoff between pizza and cookes? - `\(U = \sqrt{P*C}\)` ] .panel[.panel-name[Marginal Utility] **Marginal Utility** - the change in total utility a person receives when consuming one additional unit of a good or service - "marginal" means "additional" - slope at a specific point on the utility function with respect to one of the choices Key characteristics - **Law of diminishing marginal utility**: consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period - more of a good you have, the less happy you will be from the additional unit - exceptions?? ] .panel[.panel-name[Utility Graphs] .pull-left[ <img src="data:image/png;base64,#images/mit_2_4.png" width="100%" style="display: block; margin: auto;" /> ] .pull-right[ <img src="data:image/png;base64,#images/mit_2_5.png" width="100%" style="display: block; margin: auto;" /> ] ] ] --- ## Deriving Indifference Curves .panelset[ .panel[.panel-name[Marginal Rate of Substitution] .pull-left[ **Marginal rate of substitution** - The rate at which a consumer is willing to trade one good for another - Internal terms of trade for a consumer so that he can trade two goods for one another and still maintain the same level of utility - Given by the slope of the indifference curve Mathematically, this is the ratio of marginal utility of good X to marginal utility of good Y `$$MRS = -\frac{MU_X}{MU_Y} = -\frac{\Delta Pizza}{\Delta Cookie} = -\frac{MU_{cookie}}{MU_{pizza}}$$` Intuitively, this is the rate at which you’re willing to substitute pizza for cookies ] .pull-right[ <img src="data:image/png;base64,#images/mit_2_6.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Proof] .pull-left[ We know: $$ `\begin{aligned} U &= f(X,Y)\\ \Delta U &= \frac{\delta f}{\delta X} \Delta X + \frac{\delta f}{\delta Y} \Delta Y \end{aligned}` $$ If two points are on the same indifference curve, then we know `$$\Delta U = 0$$` So, `$$0 = \frac{\delta f}{\delta X} \Delta X + \frac{\delta f}{\delta Y} \Delta Y$$` ] .pull-right[ Now, we solve for the slope, `\(\frac{\Delta Y}{\Delta X}\)`: $$ `\begin{aligned} -\frac{\delta f}{\delta X} \Delta X &= \frac{\delta f}{\delta Y} \Delta Y\\ -\frac{\delta f}{\delta X} &= \frac{\delta f}{\delta Y} \frac{\Delta Y}{\Delta X}\\ -\frac{\big(\frac{\delta f}{\delta X}\big)}{\big(\frac{\delta f}{\delta Y}\big)} &= \frac{\Delta Y}{\Delta X}\\ -\frac{MU_X}{MU_Y} &= \frac{\Delta Y}{\Delta X} \end{aligned}` $$ ] ] .panel[.panel-name[Application] Starbucks drip coffee - Tall (12oz): $1.85 - Grande (16oz): $2.10 - Tall costs $0.15 per oz - Difference = $0.25 for 4 oz or $0.0625 per oz Why is it priced like this? ] ] --- ## Budget Constraints .panelset[ .panel[.panel-name[Overview] .pull-left[ Given your income, how much of your income can you devote to various goods/services - Assume your budget equals your income - Devote all of your income to pizza and/or cookies Graph - x-intercept - income divided by price of cookies - given your income, how much of your income can you devote to cookies? - y-intercept - income divided by price of pizza - given your income, how much of your income can you devote to pizza? - slope = (negative) price ratio ] .pull-right[ <img src="data:image/png;base64,#images/mit_3_1.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Marginal Rate of Transformation] .pull-left[ - **Example** - Income = $72 - Pizza = $12 - Cookies = $6 - Just pizza => 6 pizzas - Just cookies => 12 cookies - Rate you trade cookies is `\(-\frac{1}{2}\)` - **Marginal rate of transformation** - Slope - `\(MRT = -\frac{P_C}{P_P}\)` - Because of scarcity and tradeoffs, - the more you spend on pizza, the less you spend on cookies (and vice versa) - so MRT gives us **opportunity cost** - opportunity cost of a slice of pizza is 2 cookies ] .pull-right[ <img src="data:image/png;base64,#images/mit_3_1.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Price Change] .pull-left[ - Income = $72 - Pizza = ~~$12~~ $18 - Cookies = $6 **Opportunity set** – the set of all choices available subject to your constraints ] .pull-right[ <img src="data:image/png;base64,#images/mit_3_2.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Income Change] .pull-left[ - Income = ~~$72~~ $60 - Pizza = $12 - Cookies = $6 Note: - You have less to spend, so the income to price ratios of the axes will be affected for both pizza and cookies - The relative price of pizza and cookies hasn’t changed, so the slope doesn’t change - The slope is controlled by market, but your income controls the level ] .pull-right[ <img src="data:image/png;base64,#images/mit_3_3.png" width="100%" style="display: block; margin: auto;" /> ] ] ] --- ## Utility Maximization .panelset[ .panel[.panel-name[Intro] How do consumers make choices? - Indifference curves - Budget constraint - Maximize our utility subject to our constraints With our utility function and budget constraint function, we can find our optimal bundle of pizza and cookies ] .panel[.panel-name[Graph] .pull-left[ Knowns - utility function: `$$U=\sqrt{P*C}$$` - budget constraint: $$\$72 = \$12Q_P+\$6Q_C$$ So what is the optimal bundle? What is the utility at that bundle? Why is that the best bundle? ] .pull-right[ <img src="data:image/png;base64,#images/mit_3_4.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Tangency] .pull-left[ The slope of the *budget line* is `\(-\frac{P_C}{P_P}\)` or `\(-\frac{P_X}{P_Y}\)` The slope of the *indifference curve* is `\(-\frac{MU_{Cookie}}{MU_{Pizza}} = -\frac{MU_X}{MU_Y}\)` So at the point of *tangency*, we have `\(-\frac{MU_X}{MU_Y} = -\frac{P_X}{P_Y}\)` We have special names for these two ratios: - `\(MRS= -\frac{MU_X}{MU_Y}\)` - `\(MRT=-\frac{P_X}{P_Y}\)` *Fundamental equation of consumer choice*: - `\(MRS = -\frac{MU_X}{MU_Y} =-\frac{P_X}{P_Y} = MRT\)` ] .pull-right[ <img src="data:image/png;base64,#images/mit_3_4.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Non-tangency] .pull-left[ So what if we are not at this point of tangency - `\(\frac{MU_X}{MU_Y} > \frac{P_X}{P_Y}\)` - `\(\frac{MU_X}{MU_Y} < \frac{P_X}{P_Y}\)` The incentive is to trade until `\(MRS = MRT\)` ] .pull-right[ <img src="data:image/png;base64,#images/mit_3_4.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Normal] .pull-left[ **Substitution effect**: change in the quantity of a good when the price changes holding *utility* constant **Income effect**: change in the quantity of a good as income changes holding *price* constant **Normal good**: quantity demanded increases for the good as income rises <font color = 'lightgrey'> Inferior good: quantity demanded decreases as income rises </font> ] .pull-right[ <img src="data:image/png;base64,#images/mit_4_5.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Inferior] **Substitution effect**: change in the quantity of a good when the price changes holding *utility* constant **Income effect**: change in the quantity of a good as income changes holding *price* constant <font color = 'lightgrey'> Normal good: quantity demanded increases for the good as income rises </font> **Inferior good**: quantity demanded decreases as income rises Graph on board ] .panel[.panel-name[Norm. vs. Inf.] ### Summary of Normal vs. Inferior Goods <img src="data:image/png;base64,#images/tab_10_4.png" width="90%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Demand] .pull-left[ **Optimal Bundles** - A: original optimal bundle - B: price of cookies increases to $9 - C: price of cookies decreases to $4 What is a demand curve? A feature of the utility function I chose is that it is only a function of income and that good’s price, not the price of the other good. Is this generally true? ] .pull-right[ <img src="data:image/png;base64,#images/mit_4_1a.png" width="100%" style="display: block; margin: auto;" /> ] ] ] --- ## Example: Optimal Bundles .panelset[ .panel[.panel-name[Marginal Utility] <table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Number of Slices of Pizza </th> <th style="text-align:center;"> Total Utility from Eating Pizza </th> <th style="text-align:center;"> Marginal Utility from the Last Slice </th> <th style="text-align:center;"> Number of Cups of Coke </th> <th style="text-align:center;"> Total Utility from Drinking Coke </th> <th style="text-align:center;"> Marginal Utility from the Last Cup </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> NA </td> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> NA </td> </tr> <tr> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> 20 </td> </tr> <tr> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 36 </td> <td style="text-align:center;"> 16 </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 35 </td> <td style="text-align:center;"> 15 </td> </tr> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 46 </td> <td style="text-align:center;"> 10 </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 45 </td> <td style="text-align:center;"> 10 </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 52 </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 50 </td> <td style="text-align:center;"> 5 </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 54 </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 53 </td> <td style="text-align:center;"> 3 </td> </tr> <tr> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 51 </td> <td style="text-align:center;"> -3 </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 52 </td> <td style="text-align:center;"> -1 </td> </tr> </tbody> </table> ] .panel[.panel-name[Marginal Utility per Dollar] Suppose that pizza costs $2 per slice and Coke $1 per cup. <table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Number of Slices of Pizza </th> <th style="text-align:center;"> Marginal Utility from the Last Slice </th> <th style="text-align:center;"> Marginal Utility per Dollar </th> <th style="text-align:center;"> Number of Cups of Coke </th> <th style="text-align:center;"> Marginal Utility from the Last Cup </th> <th style="text-align:center;"> Marginal Utility per Dollar </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> 10.0 </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> 20 </td> </tr> <tr> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 16 </td> <td style="text-align:center;"> 8.0 </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 15 </td> <td style="text-align:center;"> 15 </td> </tr> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 10 </td> <td style="text-align:center;"> 5.0 </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 10 </td> <td style="text-align:center;"> 10 </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 3.0 </td> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 5 </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 1.0 </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 3 </td> </tr> <tr> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> -3 </td> <td style="text-align:center;"> -1.5 </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> -1 </td> <td style="text-align:center;"> -1 </td> </tr> </tbody> </table> ] .panel[.panel-name[Optimal Bundles] .pull-left[ <table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Number of Slices of Pizza </th> <th style="text-align:center;"> Marginal Utility from the Last Slice </th> <th style="text-align:center;"> Marginal Utility per Dollar </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 10.0 </td> </tr> <tr> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 16 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 8.0 </td> </tr> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 10 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 5.0 </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 3.0 </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 1.0 </td> </tr> <tr> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> -3 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> -1.5 </td> </tr> </tbody> </table> ] .pull-right[ <table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Number of Cups of Coke </th> <th style="text-align:center;"> Marginal Utility from the Last Cup </th> <th style="text-align:center;"> Marginal Utility per Dollar </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 20 </td> </tr> <tr> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 15 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 15 </td> </tr> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 10 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 10 </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 5 </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 3 </td> </tr> <tr> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> -1 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> -1 </td> </tr> </tbody> </table> ] Recall: `\(MB = MC\)` ] .panel[.panel-name[Optimal Bundles] <table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Combinations of Pizza and Coke with Equal Marginal Utilities per Dollar </th> <th style="text-align:center;"> Marginal Utility per Dollar </th> <th style="text-align:center;"> Total Spending </th> <th style="text-align:center;"> Total Utility </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;width: 10cm; "> 1 slice of pizza and 3 cups of Coke </td> <td style="text-align:center;"> 10 </td> <td style="text-align:center;"> $2 + $3 = $5 </td> <td style="text-align:center;"> 20 + 45 = 65 </td> </tr> <tr> <td style="text-align:center;width: 10cm; "> 3 slices of pizza and 4 cups of Coke </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> $6 + $4 = $10 </td> <td style="text-align:center;"> 46 + 50 = 96 </td> </tr> <tr> <td style="text-align:center;width: 10cm; "> 4 slices of pizza and 5 cups of Coke </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> $8 + $5 = $13 </td> <td style="text-align:center;"> 52 + 53 = 105 </td> </tr> </tbody> </table> Recall: - Pizza costs $2 per slice - Coke costs $1 per cup So you can calculate total spending and total utility Your optimal bundle depends on your budget constraint. - Which do you choose if your income is $5? - Which do you choose if your income is $10? ] .panel[.panel-name[Price Change] Suppose the price of pizza falls to $1.50 per slice. What is the optimal bundle? <table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Number of Slices of Pizza </th> <th style="text-align:center;"> Marginal Utility from the Last Slice </th> <th style="text-align:center;"> Marginal Utility per Dollar </th> <th style="text-align:center;"> Number of Cups of Coke </th> <th style="text-align:center;"> Marginal Utility from the Last Cup </th> <th style="text-align:center;"> Marginal Utility per Dollar </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> 13.33 </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> 20 </td> </tr> <tr> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 16 </td> <td style="text-align:center;"> 10.67 </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 15 </td> <td style="text-align:center;"> 15 </td> </tr> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 10 </td> <td style="text-align:center;"> 6.67 </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 10 </td> <td style="text-align:center;"> 10 </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 4.00 </td> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 5 </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 1.33 </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 3 </td> </tr> <tr> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> -3 </td> <td style="text-align:center;"> -2.00 </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> -1 </td> <td style="text-align:center;"> -1 </td> </tr> </tbody> </table> ] ] --- ## Example: Deriving Demand .panelset[ .panel[.panel-name[Utility] Suppose we face the marginal utility in the table from consuming pizza and cookies, your income is $3.00 and the price of cookies is $0.50. Find the quantity demanded if pizza is priced at $0.50 per slice and then if it is priced at $1.00 per slice. <table class="table table-striped table-hover table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Cookies </th> <th style="text-align:center;"> Marginal Utility (Cookie) </th> <th style="text-align:center;"> Marginal Utility per Dollar (Cookie) </th> <th style="text-align:center;"> Pizza Slices </th> <th style="text-align:center;"> Marginal Utility (Pizza) </th> <th style="text-align:center;"> Marginal Utility per Dollar (Pizza) </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> </td> </tr> <tr> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 120 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 120 </td> <td style="text-align:center;"> </td> </tr> <tr> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 100 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 60 </td> <td style="text-align:center;"> </td> </tr> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 80 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 45 </td> <td style="text-align:center;"> </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 60 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 30 </td> <td style="text-align:center;"> </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 40 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> </td> </tr> <tr> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 15 </td> <td style="text-align:center;"> </td> </tr> </tbody> </table> ] .panel[.panel-name[MU/$] .pull-left[ Pizza = $0.50 <table class="table table-striped table-hover table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Cookies </th> <th style="text-align:center;"> Marginal Utility (Cookie) </th> <th style="text-align:center;"> Marginal Utility per Dollar (Cookie) </th> <th style="text-align:center;"> Pizza Slices </th> <th style="text-align:center;"> Marginal Utility (Pizza) </th> <th style="text-align:center;"> Marginal Utility per Dollar (Pizza) </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">NA</span> </td> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">NA</span> </td> </tr> <tr> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 120 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">240</span> </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 120 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">240</span> </td> </tr> <tr> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 100 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">200</span> </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 60 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">120</span> </td> </tr> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 80 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">160</span> </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 45 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">90</span> </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 60 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">120</span> </td> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 30 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">60</span> </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 40 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">80</span> </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">40</span> </td> </tr> <tr> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">40</span> </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 15 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">30</span> </td> </tr> </tbody> </table> ] .pull-right[ Pizza = $1.00 <table class="table table-striped table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Cookies </th> <th style="text-align:center;"> Marginal Utility (Cookie) </th> <th style="text-align:center;"> Marginal Utility per Dollar (Cookie) </th> <th style="text-align:center;"> Pizza Slices </th> <th style="text-align:center;"> Marginal Utility (Pizza) </th> <th style="text-align:center;"> Marginal Utility per Dollar (Pizza) </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">NA</span> </td> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">NA</span> </td> </tr> <tr> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 120 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">240</span> </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 120 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">120</span> </td> </tr> <tr> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 100 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">200</span> </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 60 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">60</span> </td> </tr> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 80 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">160</span> </td> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 45 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">45</span> </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 60 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #18BC9C !important;">120</span> </td> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 30 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">30</span> </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 40 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">80</span> </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">20</span> </td> </tr> <tr> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">40</span> </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 15 </td> <td style="text-align:center;"> <span style=" border-radius: 4px; padding-right: 4px; padding-left: 4px; background-color: #959EA7 !important;">15</span> </td> </tr> </tbody> </table> ] ] .panel[.panel-name[Optimal Bundles] Recall: Income = $3.00, want quantity demanded for pizza **Bundles when Pizza Costs $0.50** <table class="table table-striped table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Bundles </th> <th style="text-align:center;"> Cookies </th> <th style="text-align:center;"> Price per Cookie </th> <th style="text-align:center;"> Pizza Slices </th> <th style="text-align:center;"> Price per Slice </th> <th style="text-align:center;"> Total Cost </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> A </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 0.5 </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 0.5 </td> <td style="text-align:center;"> 1.0 </td> </tr> <tr> <td style="text-align:center;"> B </td> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 0.5 </td> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 0.5 </td> <td style="text-align:center;"> 3.0 </td> </tr> <tr> <td style="text-align:center;"> C </td> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 0.5 </td> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 0.5 </td> <td style="text-align:center;"> 5.5 </td> </tr> </tbody> </table> <br> **Bundles when Pizza Costs $1** <table class="table table-striped table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;"> <thead> <tr> <th style="text-align:center;"> Bundles </th> <th style="text-align:center;"> Cookies </th> <th style="text-align:center;"> Price per Cookie </th> <th style="text-align:center;"> Pizza Slices </th> <th style="text-align:center;"> Price per Slice </th> <th style="text-align:center;"> Total Cost </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> A </td> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 0.5 </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 3 </td> </tr> </tbody> </table> <br> Note, we could use these quantities along with the associated prices to plot the demand curve. ] ] --- ## Experimental and Behavioral Economics .panelset[ .panel[.panel-name[Intro] > “The utility from drugs, crime, going bowling… > depends on whether friends and neighbors take drugs, commit crimes, go bowling…” > > <footer>---Gary Becker and Kevin Murphy</footer> .pull-left[ Thus far, we assumed that people - make choices independently of others - are rational-make the optimal choice This ignores - social aspects of decision making - mistakes or limits of people (bounded rationality, self-interest, willpower) ] .pull-right[ - Experimental Economics: - people are recruited to participate in lab experiments - rewarded with money to mimic real-world decision-making scenarios - Behavioral Economics - studies of people making choices that do not appear to be economically rational - bounded rationality ] ] .panel[.panel-name[Origins (Economics)] Adam Smith (1700s) - overconfidence - loss aversion: more afraid of losing than they are eager to win - self-control: more likely to pursue short-term than long-term benefits Gary Becker (1970s) - **network effects**: - the demand of one consumer is increasing in the demand of others - popularity is self-reinforcing - rational choice theory: stable preferences and engage in maximizing behavior - crime and marriage models ] .panel[.panel-name[Origins (Psychology)] Kahneman and Tversky (1970s/80s) - decisions are not always optimal--depends on framing, anchoring, etc. - rules of thumb (availability heuristic): - rely on easily recalled information, rather than actual data when evaluating the likelihood of a particular outcome - ex. bear or shark attacks - prospect theory - loss aversion - $250 guaranteed vs. 25% chance of winning $1,000 and a 75% chance of winning nothing, most people will choose the sure win - Lose $750 guaranteed vs. 75% chance to lose $1,000 and a 25% chance to lose nothing, most people will risk losing $1,000 - most people willing to take a greater risk if it means avoiding a $1,000 loss versus obtaining a $1,000 win ] .panel[.panel-name[Richard Thaler] - **endowment effect**: an emotional bias that causes individuals to value an owned object higher, often irrationally, than its market value - **sunk cost fallacy**: the idea that people will continue to invest in a losing project simply because they are already heavily invested, even if it means risking more losses - mental accounting: - the idea that people treat money differently based on context - ex.: drive across town to save $10 on a $20 football but won't to save $10 on a $1,000 TV - libertarian paternalism - libertarian because it preserves choice - paternalistic because it encourages certain behavior - **nudge**: - a conceptual device for leading people to make better decisions - Nudging examples - retirement: default into 401k - healthcare: - putting fruit at eye level or near the cash register at a high school cafeteria - default to organ donor status - *Not*: banning junk food, or punishing people for choosing unhealthy options ] .panel[.panel-name[Other concepts] .pull-left[ Altruism - motivated solely by the desire to provide for a recipient Warm glow - people experience a sense of joy and satisfaction for "doing their part" to help others - this satisfaction - or "warm glow" - represents the selfish pleasure derived from "doing good", regardless of the actual impact of one's generosity - "...a millionaire does not really care whether his money does good or not, provided he finds his conscience eased and his social status improved by giving it away..." -George Bernard Shaw ] .pull-right[ Fairness - social preference for equitable outcomes - inequity aversion: people’s tendency to dislike unequal payoffs in their own or someone else’s favor - ex: employers often agree to pay more than the minimum the employees would accept in the hope that this fairness will be reciprocated Trust - increases when people are closer socially or have high status - but less trust when people come from different social groups (e.g. nationality) ] ] ] ---